Principles of Insurance

Insurance is a system of protection against financial loss arising from uncertain future events. It helps individuals and businesses reduce the burden of risk by providing financial security. Under insurance, a person pays a small amount called premium to an insurance company, and in return, the insurer promises to compensate for loss if it occurs. Insurance works on the principle of risk sharing, where losses of a few are borne by many.

Principles of Insurance:

1. Principle of Utmost Good Faith

This principle means that both the insurer and the insured must disclose all material facts honestly. Material facts are those facts which influence the decision of the insurer while fixing premium or accepting risk. If any important fact is hidden or wrongly stated, the insurance contract becomes void.

Example

If a person takes health insurance and hides a serious illness like diabetes, the insurer can reject the claim later due to non disclosure.

2. Principle of Insurable Interest

Insurable interest means the insured must have a financial interest in the subject matter of insurance. Loss should cause financial damage to the insured. Without insurable interest, insurance becomes a gamble and is not allowed.

Example

A person can insure his own house but cannot insure his neighbor’s house because he will not suffer any financial loss if it is damaged.

3. Principle of Indemnity

This principle states that the insured should be compensated only for the actual loss suffered, not more than that. The aim is to restore the insured to the original financial position before loss. It prevents profit from insurance.

Example

If insured goods worth ₹1,00,000 are damaged and loss is ₹30,000, the insurer will pay only ₹30,000, not the full insured amount.

4. Principle of Subrogation

After paying the claim, the insurer gets the right to recover the loss from a third party responsible for the damage. This prevents the insured from getting double benefit.

Example

If a car insured is damaged due to another person’s negligence, the insurer can recover the claim amount from the wrongdoer after settling the claim.

5. Principle of Contribution

This principle applies when the same subject matter is insured with more than one insurer. All insurers share the loss in proportion to their coverage.

Example

If a factory is insured with two insurers for ₹5 lakh each and loss is ₹4 lakh, each insurer will pay ₹2 lakh.

6. Principle of Proximate Cause

This principle states that the nearest and direct cause of loss should be identified to decide the claim. The insurer pays only if the proximate cause is an insured peril.

Example

If fire caused by short circuit damages a building and fire is covered, the claim will be payable even though short circuit started the fire.

7. Principle of Loss Minimization

This principle states that the insured must take reasonable steps to minimize the loss when a risk occurs. The insured should act as if there is no insurance and try to reduce damage. Insurance does not cover losses caused by negligence after the event.

Example

If a fire breaks out in a shop, the owner should try to extinguish the fire and save goods. If he does nothing and allows the fire to spread, the insurer may reduce the claim.

8. Principle of Causa Proxima and Proximate Cause Link

This principle is closely related to proximate cause but is sometimes explained separately in exams. It states that when a series of events lead to loss, the dominant and effective cause must be identified. If the dominant cause is insured, the claim is payable.

Example

If heavy rain leads to flooding and flood damages goods, and flood is covered under the policy, the insurer will pay even though rain was the first event.